For fiscal periods beginning after December 15, 2018, businesses will have to start reporting leases differently on their balance sheets.
That’s because the Financial Accounting Standards Board and the International Accounting Standards Board released new rules that will now require businesses to record both assets and liabilities for operating leases on balance sheets. While ASC 842 and IFRS 16 are converged in many important respects, such as requiring lessees to recognize right-of-use assets and lease liabilities for most of their leases, there are significant differences between the two.
For public entities, the new standard is effective for fiscal years beginning after December 15, 2018, while nonpublic entities will have an extra year to adopt the rule. Early adoption is permitted for all entities.
The change applies to all leases except for those with a term of 12 months or fewer. The rule encompasses everything from real estate and vehicles to office equipment. Businesses will be required to report all fixed lease payments in addition to variable lease payments, which managers can record using the rate or index from the commencement of the lease, according to the Journal of Accountancy.
This change could have a significant impact on businesses’ financial reporting and affect the financial ratios they use to calculate key performance indicators and debt covenant compliance. Business owners should be prepared to list more liabilities on their balance sheets than they previously had to, and managers should know how the increased reporting of these liabilities will affect their financial reporting moving forward.
How should businesses prepare?
Managers should immediately begin evaluating how this new requirement will affect their businesses. Businesses need to consider the rule’s effects on state and local taxes, compensation agreements and accounting policies for capitalization of indirect costs.
Business owners or managers should also scrutinize every current lease agreement of their company and determine if the legislation affects any elements of the lease. Business owners should consider things such as variable rents, service components, renewal and purchase options, residual guarantees and future rent increases when thinking about how the updated standard will impact their financial reporting.
The new lease requirements can be confusing. LaPorte’s accounting professionals are constantly monitoring for updates to the new lease standards, and they can help guide you through the process of implementing the new accounting rules with ease.